Current approaches to executive pay in the UK are too complicated, outcomes are too uncertain and the system simply doesn’t deliver the right incentives. These are the key findings of a report published by the Institute of Business Ethics aimed at helping remuneration committees. ‘Fairness and a quest for simplicity should drive the process,’ says Peter Montagnon, IBE’s Associate Director and author of the report.
Fair or Unfair? Getting to grips with executive pay offers both practical advice on how remuneration committees can address the challenge and some pointers to possible reform. Montagnon reckons a good test is whether the remuneration committee can explain outcomes in a way that ordinary people can understand, which will help business in the political debate and, more importantly, help restore public trust.
The report warns that the surge in executive remuneration over the past couple of decades, high levels of reward for average performance, and occasional examples of reward for failure, suggests the present system in the UK does not deliver the right incentives.
Among the reforms suggested by the IBE are:
The report suggests that two requirements are paramount:
‘First, remuneration committees must have a clear sense of the value of what is being awarded. There is substantial doubt whether this is the case at present, despite conscientious attempts to calculate the net present value of the packages they approve. Second, remuneration committees need to do more to justify the amount they have set.’
The report explores seven challenges which remuneration committees face and suggests ways in which these challenges can be dealt with:
1. Does the remuneration committee know the value of the rewards being delivered?
2. Will the performance conditions really promote the desired behaviour?
3. Who really sets the bonus and long-term performance targets?
4. Does succession planning reduce the pressures?
5. Should executives receive a bonus for good management in a crisis or downturn where shareholders have lost money and jobs have been lost?
6. What account should remuneration committees take of pay and conditions elsewhere in the company?
7. Should remuneration be linked to culture and behaviour?
Montagnon said:
‘Fairness and simplicity are two themes running through this IBE Board Briefing. One of the reasons why executive pay has become so problematic is that it is too complicated and the outcomes often seem quite random. Another is because it enables some executives to earn very large amounts over a short period of time, while others reap only modest rewards. That can easily drive short-term decision-making. The link between remuneration and performance is not clear, so nobody, including sometimes the recipients, can tell what they are really being paid for.
A system that operates like that is bound to attract charges of unfairness and trust will ebb away. The more remuneration committees try to manipulate short-term behaviour, the less likely they are to succeed. If their focus is on long term and sustainable growth in cash generation, they will be setting their company and its executives on a course for success.’